Overhead Absorption

[gskang]

Dear all,

I am new to this forum but after reading some threads, I am very impressed by the brains in this forums.

I have a practical problem to which I need the suggestions. I hope some of you will take the time to give me some suggestions.

Supoose in a company, a product (say product A) is manufactured. This product is obviously also absorbing some overhead costs as well. Now after manufacturing the product, we have some by-products which are used to manufacture another products (say Product B and Product C) in company. These new products are also absorbing some overheads. However after few months, the company realize that these products (Product B and Product C) which were made by by-products are continously giving the loss.

My question is: is it a good idea to stop manufacturing those products (Product B and Product C)? because if the company do so, the overheads cost (which were earlier absorbed by these products) will go to another products (say D, E , F..) and may make some other products look bad too and so on. If not, what can company do in this case?

I hope I am clear but please feel free to ask if something is not clear.

I will be waiting for some suggestions.

Thanks & regards,
Gskang

[hariharm]

Hi Gskang

A couple of observations;

a) If B and C are by-products of the process of producing A, then the company cannot stop producing B and C even if it wants to.

b) But your basic question is still relevant, if A, B and C were being produced independently, and if management found that after aborbing overheads B and C were making a loss, the question is whether B and C should be discontinued. This is where management must look at the "contribution" of B and C. Contribution = Revenue - Variable Costs. If contribution is negative, discontinue the product, since each unit sold is going to result in more losses. If contribution is positive, continue production, unless you can produce (and sell) more units of other products that will yield a greater contribution.

Hope this helps.

[drtom]

Hi Gskang and hariharm , your question and the answer is very good. Adding to hariharm solution,the contribution of both products should be looked at not just only for one product since both products are bye product of product A. The contribution for both products should be positive before accepting to continue the production of A , B & C. Other things that should be considered include
1. If the contribution of products B & C is zero the company can still go ahead to produce them if bye so doing makes the bye product environmental friendly and complies with environmental regulations.
2. If the contribution per unit (in kg) of both products is Negative ( eg say �0„52/kg) but the cost of disposal per kg of both bye products is more (eg say �0„55/kg) the company should still go ahead to produce both product A, B & C.

[hariharm]

Excellent point...thanks!